Bush's Tax Panel Has a Crazy Idea. Let's Go For It

A mountain-size break: The tax deduction for mortgage interest will cost the federal government $76 billion next year. If a presidential panel's proposal to cap the deduction is adopted, it will affect wealthier homeowners in expensive urban areas, such as San Francisco, above.
(By Marcio Jose Sanchez -- Associated Press)

Pity the poor McMansion owner. If the President's Advisory Panel on Federal Tax Reform gets its way, those folks with the three-car garages, grand entryways, mega-kitchens and spacious bedrooms will lose the tax break they get for any portion of their mortgage over $312,000. In a place like Potomac, where the median sales price for a house is more than twice that amount, that could tear a hole in some fancy pocketbooks, depending on how much their owners have borrowed for their dream houses.

Oh, and that little summer cottage at the beach in Rehoboth or the lakefront place at Deep Creek or Lake Anna? That might cost a bit extra too. The panel wants to eliminate the mortgage deduction for vacation homes.

Planning on a home equity loan to consolidate credit card debt or cover your kid's college tuition? Think it through again. The president's advisory panel is expected to propose taking away the federal tax deduction for payments on that loan, too.

These are still just proposals cooked up by a bipartisan panel, and who can count how many similar proposals have gone nowhere? But it is a panel established by President Bush and charged with making the tax code simpler, fairer and more conducive to economic growth. For it to even consider going after the home mortgage deduction is a gutsy move -- even if the president recoils at the very idea.

The home mortgage interest deduction is known as the third rail of tax politics for good reason. It's loved by the people and criticized mostly by academics. It is credited with creating a nation of homeowners, spawning social stability and entire industries designed to cater to everything from financing to construction to furnishing knickknacks and beyond. Tens of millions of Americans have come to rely on the generous tax benefit -- and with home prices soaring, they aren't all McMansion owners either. In the District last year, the average house cost $415,178, according to the city's figures.

The mortgage deduction has been part of the tax code ever since the income tax became permanent in 1913 and it survived the 1986 tax reform act that got rid of deductions for most other interest payments. No one has suggested limiting these much-beloved deductions for 20 years. Politicians have been too afraid. Some of the most powerful institutions in the country, gushing with expressions of genuine concern, will rush to the defense of homeowners and fight any proposal that reduces the tax benefits associated with buying real estate.

In fact, there are many reasons why limiting the home mortgage deduction is a good thing. First and foremost: The federal government needs the money.

Next year, the home mortgage interest deduction will cost Uncle Sam $76 billion in tax revenues. Capping or limiting the deduction would raise billions of dollars, which could trim the massive federal budget deficit or help cover hefty commitments for Hurricane Katrina relief and the continuing war in Iraq.

On top of that, the administration, many members of Congress and millions of Americans would like to see something done about the "alternative minimum tax" (AMT), a minimum rate that is catching and effectively raising the rates of more and more middle-class taxpayers every year because it isn't indexed for inflation. Immediate repeal of the AMT, which was aimed originally at wealthy taxpayers, is impossible because it would cost an estimated $1.2 trillion over 10 years. Even incremental relief would cost billions. Some 20 million Americans are going to be subject to the alternative minimum tax next year.

Because of its lack of transparency, the AMT is a bad way to raise revenue. It is also politically very unpopular. The tax reform panel wants to see it repealed. Short of raising rates, which the president has vowed to oppose, there is no way to raise the money needed to reduce AMT burdens other than by trimming the mortgage deduction.

Second, reducing the home mortgage interest deduction would shift the burden of paying for our government needs to those best able to pay. Despite real estate inflation over the past several years, very few Americans carry $1 million worth of home loans. Carrying such debt remains the province of the well-to-do.

Don't feel too sorry for these wealthy fellow citizens trying to keep a stylish roof over their heads. The rich Americans lucky enough to make the payments on those big mortgages would make up for most of the loss of mortgage deductions by facing smaller AMT burdens. Besides, if history is a guide, when the deficit eventually falls, the wealthy would recoup their losses with additional tax cuts.